Preference shares

1. “Could you please explain how can we differentiate between share capital and preference shares if both of them are issued at nominal value?”

Preference shares are a part of share capital, the same as equity / ordinary shares are a part of share capital.

What makes you think that any share (preference or equity) has to be issued at nominal value? You are clearly mistaken in your thinking!

2. “Is is true that preference shares are those shares issued to the preferred shareholders but if they are not paying more than ordinary shareholders to buy a share then how they are preferred to claim their right on assets before common shareholders?”

Shares are not issued to those people that the company / directors prefer. A preference shareholder is a person that has acquired a share of a specific class of share capital offered by the company. The shares in this class enjoy (typically) rights in preference to the rights of equity shareholders.

For example, if there are sufficient profits to pay only one class of dividend, the preference shareholders will be paid rather than the equity shareholders.

In the event of a liquidation, and after ALL creditors have been paid off, the company may then have some reserves available for repayment of capital. In that situation, the preference shareholders will be paid the capital value of their shares but do not then participate in any excess funds available after their capital has been paid in full. All the rest is available for the equity shareholders

3. “Is it true that the redeemable preference shares are those which will be expired after their tenure but irredeemable preference shares are those which will never be expired but how is that possible for a business to keep paying those shareholders forever?”

Shares don’t have a fixed life term so they don’t ‘expire’. A redeemable preference share is one that the company may buy back – ie redeem -according to the terms of the share issue. An irredeemable preference share simply cannot be bought back – redeemed – and so is perpetual.

‘how is that possible for a business to keep paying those shareholders forever?”

Why not? A company (with very, very rare exceptions) has a potentially infinite life. If the company share capital has an element of irredeemable preference shares, then the company will pay the preference dividend, potentially ‘forever’

4. “Is it also true that since preference shares both redeemable and irredeemable are not part of the reserves then they cannot be paid as dividend; correct?”

Preference shares are a part of the share capital of a company. They are NOT a reserve – they are shares. Admittedly, they are a constituent part of the ‘Share Capital and Reserves’ section of a company’s Statement of Financial Position.

So, in answer to your question, you are correct that they cannot be paid as dividend. But you are correct for a combination of utter confusion and a lack of understanding that goes, potentially, as deep as the basic principles of double entry and debits and credits!

Preference share capital is a credit balance – it cannot ever be a debit balance. The double entry to record the payment of a dividend is:

Dr Reserves (typically the Revenue Reserve / Accumulated Profits Reserve) and
Cr Cash

If your question is ‘Instead of debiting Accumulated Profits / Revenue Reserve, is it possible to debit Preference Share Capital’ the answer is a resounding NO!

OK?